Friday, April 20, 2018

IMF Issues New Report on Expanded Role for the SDR

Last fall the IMF announced it would begin a study to see if an expanded role for the SDR might improve the financial stability of the international monetary system. This month the IMF issued a report on some of its findings. Below I have pasted in that report. I added bold type for a few points I wanted to emphasize.

IMF Executive Board Discusses the Role of SDR

April 11, 2018

On March 30, 2018, the Executive Board of the International Monetary Fund (IMF) discussed a staff paper entitled Considerations on the Role of the SDR. The paper explores whether a broader role of the SDR could contribute to the smooth functioning and stability of the international monetary system (IMS). It provides an updated assessment of the IMS, highlighting its considerable resilience but also some weaknesses—a weak external adjustment mechanism, gaps in international liquidity provision, and large-scale reserve accumulation— and explores whether the SDR could play a broader role in mitigating these weaknesses.

Conceptually, there are three distinct forms of the SDR: official SDRs, the reserve asset administered by the IMF (O-SDR); SDR-denominated financial instruments, or “market SDRs” (M-SDR); and the SDR as a unit of account (U-SDR). The O-SDR was conceived under the Bretton Woods gold exchange standard as an international reserve asset to supplement existing reserve assets. As the IMS evolved, and despite the aim of the Second Amendment of the Articles of Agreement to make the SDR “the principal reserve asset in the international monetary system,” the SDR’s role as an international reserve asset has been limited. Interest in both the U-SDR as the unit of account to price international trade or for the dissemination of statistics, and M-SDR as the denomination for financial instruments such as bank deposits, loans, or securities, has been sporadic with low overall uptake.

The staff analysis concludes that among the three conceptual forms of SDR, the O-SDR has the greatest potential to contribute to the smooth functioning of the IMS under a different legal framework that would require amendments to the Fund’s Articles of Agreement. The paper highlights, among others, the major challenges around scale, targeting and the use of O-SDR allocations. It argues that widespread M-SDR and U-SDR use would likely make more limited contributions to systemic IMS stability and face significant implementation challenges. The paper also aims to initiate a conversation about the SDR’s role amid uncertainties caused by economic and technological developments, such as the prospect of a more multipolar global economy and the impact of financial innovation and new technologies.

Executive Board Assessment

“Executive Directors welcomed the opportunity to discuss whether the SDR could play a broader role in contributing to the smooth functioning and the stability of the international monetary system (IMS). Many Directors noted that the IMS had shown considerable resilience and strength, including during the global financial crisis (GFC), and a few noted that it had been further strengthened after the GFC. Directors noted, however, that the IMS continues to face several important challenges, mainly related to external adjustment mechanisms, gaps in official provision of international liquidity, and systemic side effects of large scale reserve accumulation. In this context, Directors reflected on whether an enhanced role for the SDR could help in mitigating the observed weaknesses of the IMS and complement other efforts such as global policy coordination, enhanced surveillance, and a strengthened global financial safety net (GFSN), alongside countries’ own efforts to increase resilience through sound domestic macroeconomic policies and strong policy frameworks.Most Directors were uncertain or unconvinced that there is a role for the SDR in addressing the weaknesses of the IMS. A number of Directors, however, considered that there is a potential for the SDR to address these gaps and saw merit in continuing to explore its future role.

“Directors discussed whether an expanded role of official SDRs (O SDRs) could help smooth external adjustment, augment the supply of safe global assets, and reduce incentives for precautionary reserve accumulation. In this context, while a number of Directors saw a potential for additional O SDR allocations to help foster greater IMS stability, most were not convinced that it could be effective in addressing the IMS gaps. Many Directors noted that the 2009 SDR allocation played an important role in mitigating the impact of the GFC. Nevertheless, many Directors also cautioned that such allocations could raise moral hazard concerns, including reluctance in some recipient countries to enact needed policy adjustments, although a few felt that such concerns might be overstated and could be mitigated through increased transparency and effective surveillance. Some Directors also doubted whether voluntary trading participants would be willing to support high volumes of O SDRs. A number of Directors expressed skepticism regarding alternative targeting mechanisms for SDR allocations, such as allocations contingent on global conditions or meeting policy criteria, noting that it would blur the distinction between conditionality based Fund lending and the role of the SDR as reserves. Many Directors noted that such alternatives would require amending the Articles of Agreement and resolving a number of operational considerations, such as the allocation of credit risk.

“Most Directors saw limited scope for market based SDRs (M SDR) and SDRs as a unit of account (U SDR) to contribute to systemic stability. Despite the benefits of diversification and stability of payments and receipts, uptake would be hard to achieve even with official sector support to reduce transaction costs and develop market liquidity and infrastructure. A number of Directors, however, saw merit in exploring these issues further, and a few called for a more active role for the Fund to contribute to the development of SDR market infrastructure.

“Directors welcomed a preliminary discussion of economic and technological transitions, such as a potential move toward a multipolar global economy and adoption of financial technologies, and their impact on the IMS. Most supported further analysis of how these developments could reshape the IMS in the future, noting that the role of the SDR either should not be the central question in this analysis or need not be explored at all. It was also suggested that staff should focus more on issues such as exchange rate adjustment, excess reserve accumulation, and global rebalancing.”

-------------------------------------------------------------------------------------------------------------------My added comments: As we can see from the report above, the IMF continues to look at the idea of some kind of expanded role for the SDR in the international monetary system. We have covered that extensively here since Jim Rickards continues to predict that when the next major global financial crisis arrives, the SDR will be put forward to replace the role of the US dollar as global reserve currency.Along those lines, we have also extensively covered the Real SDR proposal of Dr. Warren Coats (former IMF) which is a real detailed proposal the IMF could consider at some point in the future. We have evenpublished a direct Q&A interview with Dr. Coats on this proposal. Looking at this new release from the IMF, I don't see any indication that there is much momentum inside the IMF for much major change at this time. Please note the bolded sections above which state clearly that "most (IMF) Directors were uncertain or unconvinced that there is a role for the SDR in addressing the weaknesses of the IMS (International Monetary System)." Also, see this quote from the concluding paragraph:"Most (IMF Directors) supported further analysis of how these developments could reshape the IMS in the future, noting that the role of the SDR either should not be the central question in this analysis or need not be explored at all."

This is in line with what I heard for some time from experts like Dr. Coats and what we have reported here. I continue to believe that without a new major global financial crisis, the impetus for major change to the existing monetary system does not exist right now. This is why we have focused on keeping an eye on any events that might lead to a new major crisis. That would be the trigger point that could change the dynamic of the situation and allow for new ideas to be put forward. We will continue to monitor events that might lead to a new crisis, but unless we see those emerge by mid to fall 2018, we will end regular blog articles here and simply continue to monitor events and wait for something significant to report. Meanwhile, readers can access our list of potential systemic riskshere and various proposals for monetary system change here. If a new crisis does emerge, this information will be valuable for readers to be able to access.

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